For small businesses, receiving a notice of a customer’s bankruptcy can be confusing. While the best advice is always to contact an attorney to determine the exact impact of the bankruptcy, the analysis can be broken down into a few basic steps following the receipt of a bankruptcy notice.
Stop Collections and Gather Information
With very few exceptions, upon the filing of a bankruptcy by an individual, the automatic stay of the bankruptcy code generally prohibits further collection activities or legal actions against that individual and his or her property. The focus of a business that receives a bankruptcy notice should first be on identifying the debtor in its customer records, determining what, if any, collection actions it has pending, and ceasing those collection actions as well as the generation of further billing statements to the customer.
Most creditors will learn of the bankruptcy filing by receiving a written notice in the mail. This notice is the first document generated by the Court upon the filing of a bankruptcy petition by an individual and it includes key information that the creditor should review. For example, the notice will indicate the full name and social security number of the debtor to aid in the creditor’s identification of the individual in its customer rolls. The bankruptcy case number will also be disclosed and should be referenced by the creditor in any correspondence it sends to the bankruptcy court related to the debtor.
The notice also includes the chapter that the debtor has filed, typically 7 or 13 for consumer debtors, and the date, time and location of the Meeting of Creditors. The chapter is particularly important because it will provide an early indication of whether funds might be available for the creditor in the case. Typically Chapter 13 bankruptcies provide some level of distribution to the creditor, albeit often just a small percentage for many general unsecured creditors. Chapter 7 bankruptcies may also produce dividends for the creditors, but whether funds will be available is typically not something that the creditor will be able to determine at such an early stage in the case.
Determine the Impact of the Bankruptcy
Many small business creditors mistakenly ask whether their debts are “included” in the bankruptcy. Technically this is not correct since all debts must be included, that is, listed and noticed, in the bankruptcy petition. The real question is whether a particular debt will be discharged or wiped out by the bankruptcy. The answer to that question depends in large part on whether the debt owed to the creditor satisfies one or more of the exceptions to discharge found in the Bankruptcy Code.
The Bankruptcy Code lists a number of types of debts that are not discharged in a bankruptcy. Examples include certain types of taxes, child and spousal support obligations, and student loans that would not typically impact a small business creditor. Small business creditors often need to look more to the manner in which the debt was incurred. For example, such businesses may be able to assert that a debt should not be discharged because it was incurred by fraud or by the misrepresentations of the debtor.
Also, the receipt of a bankruptcy notice does not necessarily mean that the creditor will not receive further payments toward the debt. In Chapter 13 cases, the debtor’s proposed plan will be mailed to all creditors and provides information on what payments a creditor might expect. In Chapter 7 cases, the debtor files a Statement of Intention that indicates whether he or she will continue to make payments to certain creditors that have liens on the debtor’s property.
Consider Whether Further Action is Necessary
When faced with a customer’s bankruptcy filing, the creditor’s range of options extend from taking no action to becoming actively involved in the case, reviewing all filings and attending court hearings. Although much of the initial information gathering can be done without the assistance of an attorney, determining the effect of the bankruptcy filing and evaluating whether further action is necessary typically will require the expertise and advice of an attorney.
The bankruptcy process actually includes a fair amount of safeguards for creditors even if they do not participate in the case. Other parties, such as case trustees, are assigned to all consumer cases and oversee parts of the process. Although these trustees are not responsible for protecting the rights of any particular creditor, they will often bring to the attention of the Court issues related to the debtor’s eligibility to seek bankruptcy relief.
Even if a creditor does not intend to become actively involved in a case, it should consider filing a proof of claim with the Court if distributions are likely. A blank proof of claim form normally will accompany the initial bankruptcy notice from the Court in all Chapter 13 filings since some level of distribution to creditors is anticipated in such cases. For Chapter 7 cases, the Court generally only issues a notice to creditors to file a proof of claim in a case where distributions are expected. Timing is important, however, and a creditor needs to ensure its proof of claim is filed before the deadline noted for such claims.
A common misconception is that creditors must attend the Meeting of Creditors hearing or they will not be able to further participate in the bankruptcy. This is not true. The failure to attend the meeting of creditors by the creditor does not eliminate any of its rights with respect to the bankruptcy. It is an optional meeting that simply provides basic information about the case and the opportunity for questions to be asked of the debtor regarding his or her debts and property interests.
Depending on the circumstances of a particular case, some creditors may consider becoming more deeply involved in the proceedings. Creditors will want to consult with counsel before taking actions such as objecting to the debtor’s plan of reorganization, filing a special lawsuit to ask the Court to determine that a debt is not discharged, seeking dismissal of the case, or asking the Court to lift the automatic stay in order for normal collections to proceed.
Although small business creditors are understandably concerned with incurring more expenses and legal fees when faced with a customer’s bankruptcy filing, hiring counsel is always advisable when dealing with significant accounts. As with any legal matter, a business is best positioned to limit the impact of a bankruptcy when that business understands the process and its options.
Of course, the question that forms the title of this article is asked tongue in cheek. For my clients, losing the property they want to keep is never the goal! So the real question is how do you maximize your chances of keeping your property in a Bankruptcy. The answer is simple. You follow the rules. Knowing the rules, though, is often the real challenge.
Unfortunately, in today’s world of the internet and easy access to information, it is easy for a potential client, armed with a little bit of knowledge from his or her internet legal research, to make some big mistakes before even meeting with an attorney in preparing for a Bankruptcy filing. Often, such an individual’s efforts to try to protect property or to limit the impact of a Bankruptcy on his or her loved ones backfires because the legal system has many built-in protections to ensure fairness to all parties and to discourage any “funny business” by clients to avoid their creditors.
What do I mean by “funny business?” I have had clients ask not to list a specific debt and tell me “I don’t want to include that family member in my Bankruptcy.” Other clients have reported to me at our initial meeting that they no longer have a car or other bank account when asked about their assets. When pressed, the client admits that in anticipation of our meeting, they have “put the car in someone else’s name so it won’t be a problem.” Of course, there are still other clients who never reveal information to me because they think that will help them better protect certain prized possessions. All of these efforts at trying to protect property or specific creditors are ill-advised and almost always result in the direct loss of that property or in sanctions on the clients themselves. Those sanctions can include the simple denial of a client’s discharge of debt, the loss of assets, or even imprisonment for fraud.
Not Listing a Family Member
A main tenet of the Bankruptcy system is fairness to all parties, including all of the creditors and the clients themselves. Of the misdeeds described in this article, arguably the most innocent may the desire of a client to not discharge a debt to his or her family member by not revealing that obligation on the Bankruptcy petition. While I can appreciate that such desire stems from a client’s interest in protecting his or her family member as well as protecting the client’s own pride, the Bankruptcy Code clearly requires that all debts are disclosed regardless of whether the money is owed to family, friends or one of the big national banks. The Bankruptcy Code is designed to ensure that all creditors are treated fairly and have notice of the proceeding. For example, if distributions will be made to creditors in the case, all creditors including family members have the right to participate. By failing to list a family member in a petition, the client is effectively denying that family member the right to receive distributions or to raise other appropriate issues in the Bankruptcy forum.
Recent Transfers of Property
Some individuals mistakenly believe that giving away, selling or transferring property “out of their names” will protect the asset in a Bankruptcy. Sometimes I see this with priceless family firearms that have been passed down through generations. Other times, for example, I have had clients tell me about cars they put in their son’s name or bank accounts they closed out. In most of these cases, the very action the clients have taken to try to protect their assets is the action that will ensure that they lose them.
With respect to the firearm example, a client in Bankruptcy typically could have easily protected the item through special inheritance or firearm exemptions if they just retained ownership of it and disclosed it. By transferring the property out of one’s name, the Bankruptcy Trustee might be permitted to void the transfer and recover the item to sell and pay to creditors. The example of the transferred car on the eve of Bankruptcy would work the same way with the same disastrous result. Typically it is easier to protect an asset by disclosing it in the Bankruptcy and applying the appropriate exemption.
In the case of bank accounts, there may, in fact, be limited amounts of cash a client can protect. However, with an experienced attorney’s assistance, a client may have opportunities to convert that cash into other exempt assets, like pre-need funeral contracts, necessary household goods and furnishings, or prescribed medical devices. Such pre-bankruptcy planning, though, can be fraught with complications for the client and should be approached cautiously and only with careful attorney instruction. If not, a well-meaning client might be seen as overreaching and face allegations of fraud. The courts rarely define how much pre-bankruptcy planning is appropriate, and legal scholars generally sum matters up with the simple maxim, “pigs get fed and hogs get slaughtered.” In other words, while some reasonable, appropriate and necessary pre-bankruptcy planning may be appropriate, if such efforts are too aggressive and appear in bad faith, the client risks losing his Bankruptcy discharge, the assets, or worse.
Hiding or Failing to Disclose Assets
The biggest mistake a client can make is to fail to disclose actual assets on a Bankruptcy petition. An example of this would be the client who does not report a potential claim they may have against a third party, such as a car accident personal injury lawsuit or other claim. If the goal behind the nondisclosure is a client’s expectation that it will keep the Bankruptcy from negatively impacting the lawsuit, the client will be surprised to learn that his or her very actions will actually bar the personal injury claim or other lawsuit from proceeding further. In fact, the client will effectively give up any rights he or she may have had to the lawsuit and to the damages award that might otherwise flow from it by failing to disclose the potential asset in the Bankruptcy petition. The irony is that in most personal injury cases, the damages award would be fully exempt and protected in a Bankruptcy proceeding if properly disclosed.
Over the years, courts all across the country have written opinions to reiterate that the “fresh start” offered by Bankruptcy is reserved for the “honest but unfortunate” individuals facing overwhelming debt. The key is in the word, “honest.” Preserving the right to the relief offered by Bankruptcy requires that the client proceed honestly, in good faith, and according to the rules of the system.